Losing out on £2,500-a-year: How the new state pension will leave millions of workers rich and poor worse off

Millions of private sector workers, many of whom are on low pay, stand to be thousands of pounds worse off in retirement under the new state pension system compared to the current one.

Workers earning as little as £5,772-a-year stand to make more from the existing two-tier system of basic state pension and second state pension (S2P), than they would under the new flat-rate state pension being introduced from April 2016.

The Government has championed its single-tier state pension as 'fairer and simpler' than the complicated system currently in place, but it will be public sector workers and the self-employed who benefit the most, while private sector workers both rich and poor will lose out on potentially tens of thousands of pounds in retirement.

Before or after? Private sector workers retiring after 2016 face the possibility of getting a worse state pension under the new regime.

Figures compiled for This is Money by MGM Advantage show that someone earning just £5,772-a-year with 30 years of National Contributions and S2P entitlements would get, based on this year's numbers, a basic state pension of £113.10 plus S2P contributions of about £53-a-week, a total of £166.10-a-week.

The new single-tier pension is expected to be worth around £155-a-week by the time it is introduced, providing £11.10 less than this a week, or £577 a year.

Someone earning £30,000 meanwhile with 30 years of S2P accrual would be entitled to around £185-a-week under the existing system, an extra £30-a-week or more than £1,500 extra every year.

The worst off will be those accruing the maximum amount of S2P - people on £40,040 and over - who would have been entitled to £200-a-week in retirement, some £2,530-a-year less than they stand to get under the new system.

It has been no secret that these workers would be the ones to lose out in the new regime, but it will be particularly galling to private sector employees who are already on workplace pension schemes of lesser quality than those in the public sector.

OUT WITH THE OLD

Current system

30 years NI contributions & S2P accrual

Earning £5,772-£15,100

Possible state pension: £166.10-a-week

Earning £30,000

Possible state pension: £185-a-week

Earning £40,040-plus

Possible state pension: £200-a-week

New system

35 years NI contributions

Possible state pension: £155-a-week

Andrew Tully, of MGM Advantage, who compiled the figures for This is Money, said: 'Many people would have got better benefits in S2P (or the state earnings-related pension) than under the new flat-rate scheme.

'However, the overall position is relatively complex and there are some winners and losers. Self-employed, for example, are likely to be better off under the new system.'

The Department for Work and Pensions (DWP) has pointed out that rules on S2P changed in 2012 to make it more generous to lower earners, and that someone who had worked over the past 30 years may not have built up these levels of entitlements by now.

But that doesn't change the fact that young and middle-aged workers in this situation would have built up better state pensions if rules were to stay as they were and they retired a few decades down the line.

The Government has said that anyone retiring after 2016 with larger state pension entitlements than the flat-rate pension will have them honoured.

A DWP spokesman said: 'Our reforms simplify the current state pension system, which is too complicated and leads to misunderstanding and confusion for individuals. Clearly though, with such a major reform, transitional arrangements will be necessary to ensure people are treated fairly.

'Anyone who has already paid additional contributions towards S2P in years gone by will see this reflected in what they receive - even after 2016 - provided that they have contributed for at least 10 years. This may mean they get more than the full rate of the new State Pension.'

They added: 'It is worth bearing in mind the flat rate S2P has only been in place since 2012 so this sort of calculation only works for looking at someone's future career.'

The main winners from the new state pension system will be the self-employed, who are not allowed to build up S2P entitlements under the current regime, those with incomplete National Insurance records, and those who were 'contracted-out' of S2P.

Limited impact: Those retiring in the next decade will not be as hard hit by the scrapping of S2P as they may have already built up entitlements that will be honoured by the Government.

Contracted-out workers are typically found in the public sector and tend to be members of final salary pension schemes. They agree to waive their right to S2P, having to make do with the basic state pension, in exchange for paying a lower amount of National Insurance and a larger workplace pension.

Under the single-tier system, they will no longer be able to contract-out and so will build up entitlements to the new basic state pension, which will be far more generous than the current basic state pension.

However, to get the full state pension under the new system, workers will have to make 35 years of National Insurance contributions, compared to just 30 years now.

But Mr Tully said that while many will lose out in future years on larger state pensions, the move to a flat-rate state pension will eradicate much of the complexity in the existing system.

He said: 'In the longer-term though it will give a much simpler system which is more likely to be understood – rather than the horribly complex second tier provision we currently have.

'The key is we need some stability in state pension provision. The constant changes we have seen over the last 20 years and more make it very difficult for people to plan with any certainty.'